History Vs. Expectations

Abstract

In models with external economies, there are often two or more long run equilibria. Which equilibrium is chosen? Much of the literature presumes that "history" sets initial conditions which determine the outcome, but an alternative view stresses the role of "expectations", i.e. of self-fulfilling prophecy. This paper uses a simple trade model with both external economies and adjustment costs to show how the parameters of the economy determine the relative importance of history and expectations in determining equilibrium.